In November 2008, the U.S. Department of Treasury issued final regulations (the “Final Regulations”) that implement the Foreign Investment and National Security Act of 2007 (FINSA). FINSA, which overhauled Section 721 (commonly known as the “Exon-Florio” section) of the Defense Production Act of 1950, allows the President, acting through the Committee on Foreign Investments in the United States (CFIUS), to review and investigate certain transactions whereby a foreign person acquires control over a U.S. business to determine the effect of such transactions on U.S. national security.

The CFIUS review process operates based on a voluntary notification system, allowing parties to a transaction to determine whether to initiate a review by filing a notice with CFIUS. Transactions that are notified to CFIUS for review and that are not found to present national security concerns may qualify for a statutory “safe harbor,” meaning that the transaction may proceed without the threat of suspension or prohibition. On the other hand, transactions that are not voluntarily notified to CFIUS and that are found to present national security risks may be subject to suspension, prohibition, the imposition of post-closing conditions, or even postclosing divestiture in cases where the transaction has already completed. Thus, parties to foreign acquisitions should carefully evaluate whether CFIUS notification is appropriate by determining whether the potential benefits of notifying the transaction to
CFIUS outweigh the costs and burdens involved in making such a notification. In evaluating whether CFIUS notification is appropriate, a party must determine (1) whether the foreign acquisition is a FINSA-covered transaction (i.e., whether it will result in the control of a U.S. business by a foreign person), and (2) whether the foreign acquisition presents any national security concerns.

Control of a U.S. Business by a Foreign Person

FINSA provides no bright-line rule or ownership threshold for determining whether a transaction will result in a foreign person having control over a U.S. business. Rather, the Final Regulations state that CFIUS approaches its analysis as to whether control has been acquired on a case-by-case basis, and focuses on whether the transaction could result in the foreign person having the ability to determine, direct or decide “important matters” affecting the target U.S. business. These matters might include, for example, decisions on whether to sell, pledge or lease principal assets; reorganize, merge or dissolve the entity; make major expenditures; issue equity, debt or dividends; appoint or dismiss managers, officers or key employees; or amend the governing documents of the entity.

Under FINSA, control may be exercised directly or indirectly, meaning that a person cannot avoid being deemed to control a U.S. business for FINSA purposes by exercising such control indirectly through an affiliate or unrelated third party. Control may also exist where unrelated parties, which may not have the ability to control important matters of an entity acting alone, agree to vote collectively as a single block on any of the aforementioned “important matters.” Further, CFIUS’s determination of control considers a party’s ability to control an entity, not whether the ability to control is actually exercised by the party. Thus, a foreign person cannot avoid a determination that it
controls a U.S. person for FINSA purposes by contractually agreeing not to exercise its voting control or by choosing not to exercise its control.

Types of transactions that, per the Final Regulations, are generally not subject to FINSA include start-up investments, minority shareholder rights, passive investments of 10 percent or less, and lending transactions.

National Security Concerns

FINSA authorizes CFIUS to review certain foreign acquisitions to determine the effect on national security. Similar to the CFIUS determination of whether control is acquired in a particular transaction, the CFIUS determination of whether a transaction poses national security risks involves no bright-line rules and is decided based on the facts and circumstances of a particular case.

In its national security analysis, CFIUS generally considers (i) the nature of the foreign person acquiring the U.S. business, and whether the foreign person has the capability or intention to cause harm to U.S. national security; and (ii) the nature of the U.S. business being acquired, and whether it involves a U.S. system, entity or structure that is vulnerable to espionage or sabotage. The factors that might be considered in this analysis include the following:
– The potential national security-related effects of the transaction on projected national defense requirements (e.g., availability of products, technology and materials) and long-term requirements for energy assets and other critical resources
– Whether the transaction may result in sales of military goods, equipment or technology to countries that present national security concerns (e.g., terrorism, military threats, and nuclear, chemical or
biological weapons proliferation) to the U.S.
– Whether the transaction could result in the control of the U.S. business by a foreign government or an entity controlled by a foreign government.

Examples of the types of transactions that the Department of Treasury has stated may pose national
security concerns to CFIUS include the following:

Government Contractors and Subcontractors. Transactions that involve the acquisition of prime contractors and subcontractors of U.S. federal, state and local governments may be deemed by CFIUS to present national security concerns. Companies that have access to U.S. classified information (including in the defense, security and law enforcement sectors) may be of particular interest to CFIUS. In addition, CFIUS may apply scrutiny to foreign acquisitions of U.S. businesses that supply goods or services to U.S. agencies involved in national security.

Energy, Transportation and Financial Industries. CFIUS may perceive acquisitions of U.S. businesses involved in the energy, transportation and financial industries to present national security implications. These types of businesses may include, for example, businesses that transport natural resources, convert national resources to power, or provide power to U.S. citizens or the government.

Advanced Technologies and Export-Controlled Goods and Services. Transactions where a foreign person acquires a U.S. business that is involved in the development of certain advanced technologies, and specifically technologies that may be useful in defending, or seeking to impair, national security, may be of interest to CFIUS. In addition, CFIUS may perceive the acquisition of businesses involved in the development, production or supply of cryptography, data protection, Internet security and network
intrusion protection as presenting national security concerns.

Foreign Government Acquisitions. CFIUS may be interested in transactions that could result in control of a U.S. business by a foreign government or a person controlled by or acting on behalf of a foreign government (including foreign government agencies, state-owned enterprises, government pension funds and sovereign wealth funds). In such foreign government-controlled transactions, the record of the country in question with regard to non-proliferation and other national security matters
is likely to be considered by CFIUS in its review.

Conclusion

Parties to a foreign acquisition should consult their legal counsel to determine whether CFIUS notification is appropriate based on the relevant facts and circumstances of the transaction. By notifying the transaction to CFIUS, the parties may be able to move forward without running the risk of having CFIUS suspend, prohibit or impose conditions on a contemplated transaction, or undo a completed transaction.